Article that Explains our Debt Trap

[JerichoHill]

See, Integral, eventually i knew you'd get to my point where you stop bothering trying to explain economic reality...

@Conspirator
Don't call out a longstanding member like Cutlass, call him completely wrong, and calling him blinded ignores a very long history that he has, with many members,including myself where Cutlass had very engaging conversations and both folks came out with better understandings of alternative positions.

 

[Cutlass]

See, Integral, eventually i knew you'd get to my point where you stop bothering trying to explain economic reality...

See, this is what I miss. Although I understand your frustration, I regret the outcome of that frustration. Because often the debate of economic ideas is one of my favorite things on OT. And there really isn't very much of it any longer.

 

[JerichoHill]

Cutlass,

It's a regrettable problem of the internets. You know you're always welcome to discuss stuff with me!

 

[G-Max]

As for the debt, sound macro economic policy says to run deficits in bad times, balance the budget most other times, pay down the deficit in good times. Obama's problem is that the Republican orthodoxy reverses this and the Republicans believe in running deficits at all times that a Democrat wouldn't get credit for the results.

Just because the Republicans are utterly and completely fiscally irresponsible does not mean that other people are required to be also.

You say that as if the Democrats are any different.

 

[Cutlass]

You say that as if the Democrats are any different.

90% of the US national debt is Republican policies enacted with almost complete Republican support and mostly Democratic opposition.

 

[G-Max]

By science?

I ain't Tomas Dolby, science doesn't blind me.
Think you're smart? Form a line behind me!
You won't find me, truth to tell,
to be a man who suffers fools very well.
Quite the opposite, in fact;
ain't got time to interact...

90% of the US national debt is Republican policies enacted with almost complete Republican support and mostly Democratic opposition.

Nonsense. Over half of our budget is spent on entitlements, and entitlements are the Democrats' sacred cows. The Republicans' sacred cow is the military, which only accounts for less than 20% of the budget.

 

[Rashiminos]

If you believe that, then why ever create more of it?

It vomits on your shirt. It needs 24/7 attention. It could be the leader of the Free World in 35 years.

This thread has already been derailed since page 1, and not by the most obvious suspect.

 

[Cutlass]

Nonsense. Over half of our budget is spent on entitlements, and entitlements are the Democrats' sacred cows. The Republicans' sacred cow is the military, which only accounts for less than 20% of the budget.

That doesn't even begin to make the smallest lick of sense. Reagan inherited very little deficit, he pushed through policies that caused huge deficits. Bush inherited a current budget surplus, be pushed through polices that doubled the accumulated debt and caused an economic collapse on top of it.

 

[G-Max]

That doesn't even begin to make the smallest lick of sense. Reagan inherited very little deficit, he pushed through policies that caused huge deficits.

The Democrat-controlled Congress was responsible for all legislation passed during that period.

Bush inherited a current budget surplus

Nope, though the budget was pretty close to balanced thanks to Newt Gingrich and a GOP-controlled Congress.

pushed through polices that doubled the accumulated debt

He inherited a dot-com bubble that was months away from bursting, and then we had to go hunting for some guy who destroyed some buildings in New York and killed thousands of people. Of course, once the Democrats retook Congress from him, our deficit situation didn't change much.

and caused an economic collapse on top of it.

The housing bubble started in the '70s, dude.

 

[Cutlass]

The Democrat-controlled Congress was responsible for all legislation passed during that period.

A Republican controlled Senate. Funny how often that gets forgotten. And you still have to ask who voted for it. If all Republicans and a couple of Democrats voted for it, then it's a Republican policy.

Nope, though the budget was pretty close to balanced thanks to Newt Gingrich and a GOP-controlled Congress.

Newtyboy tried to spend more money than Clinton in every year.

He inherited a dot-com bubble that was months away from bursting, and then we had to go hunting for some guy who destroyed some buildings in New York and killed thousands of people. Of course, once the Democrats retook Congress from him, our deficit situation didn't change much.

That's still a balanced budget. He cut taxes and refused to improve the economy while drastically increasing spending.

The housing bubble started in the '70s, dude.

The financial crisis is not the housing bubble. Deregulation, mostly by Bush, allowed most of it.

 

[Integral]

The financial crisis is not the housing bubble.

This is a true statement and one that more people need to understand.

 

[classical_hero]

Well then what caused the financial crisis?

 

[Cutlass]

Well then what caused the financial crisis?

The speculation, fraud, mismanagement, and manipulations within the financial services industry that was a substantial part of fueling the housing bubble.

 

[classical_hero]

But in the most simple terms it is correct to say that the housing bubble played a big part in that, since much of the speculation came as a result of bets on the housing sector.

 

[Integral]

I have a "crazy' theory. So you'll want other people's stories as well.

The story I see looks something like this.

Housing bubble and runup in housing construction from 2000-2006. Housing price bubble pops in 2007. From mid-2007 to mid-2008 we have a garden-variety recession.

From June to August 2008, a series of shocks hit the American economy.
(1) Continued fallout from the housing bubble which ripples through the financial sector. Nobody has any clear plan of what to do with very large problem banks. Consider this a "demand" shock to money velocity.
(2) The oil price spike in June 2008 was "exogenous" to the American economy and represented a mild supply shock.
(3) Contemporaneously, "confidence" falters as private expectations of future income fall dramatically. (source: U Michigan Survey of Consumers). A 'demand shock" to consumption.
(4) real interest rates soar upward (source: look at the yield on inflation-indexed bonds as a proxy for real interest rates). A "demand shock" to investment.

As a result of these shocks the demand for money (or, equivalently, safe assets like Treasury bills) increased.

However the Fed and Treasury did not act to meet that increased demand. Monetary policy loosened in absolute terms but not relative to where they needed to be.

The "crash" in October-November 2008 was precipitated by a contraction in aggregate demand caused by tight money, falling expectations of future income and soaring real interest rates.

Monetary policy continues to be tight relative to where it needs to be, even today. That's why unemployment is so high and output so low. We can also see this in tepid realized inflation, low inflation expectations and continued low asset prices.

In short: mild "real" recession from mid-2007 to mid-2008. Tight monetary policy (relative to where it needed to be) drove the economy off a cliff in June-August 2008. Large recession followed.

But again, this is a story that I piece together using evidence from the Great Depression and the 1987 stock market crash. The basic causality is "tight money -> financial crash -> recession." It's not the financial crash that caused the recession, it's tight money.

What I need to do now is piece together a causal story that is plausible to people other than monetary economists.

 

[Cutlass]

You do have to say that they are hopelessly intertwined. However, we could have had the whole of the housing bubble come and go without the financial crisis. And without the financial crisis, the size of the whole problem would have been far, far, smaller.

 

[Cutlass]

I have a "crazy' theory. So you'll want other people's stories as well.

The story I see looks something like this.

Housing bubble and runup in housing construction from 2000-2006. Housing price bubble pops in 2007. From mid-2007 to mid-2008 we have a garden-variety recession.

From June to August 2008, a series of shocks hit the American economy.
(1) Continued fallout from the housing bubble which ripples through the financial sector. Nobody has any clear plan of what to do with very large problem banks. Consider this a "demand" shock to money velocity.
(2) The oil price spike in June 2008 was "exogenous" to the American economy and represented a mild supply shock.
(3) Contemporaneously, "confidence" falters as private expectations of future income fall dramatically. (source: U Michigan Survey of Consumers). A 'demand shock" to consumption.
(4) real interest rates soar upward (source: look at the yield on inflation-indexed bonds as a proxy for real interest rates). A "demand shock" to investment.

As a result of these shocks the demand for money (or, equivalently, safe assets like Treasury bills) increased.

However the Fed and Treasury did not act to meet that increased demand. Monetary policy loosened in absolute terms but not relative to where they needed to be.

The "crash" in October-November 2008 was precipitated by a contraction in aggregate demand caused by tight money, falling expectations of future income and soaring real interest rates.

Monetary policy continues to be tight relative to where it needs to be, even today. That's why unemployment is so high and output so low. We can also see this in tepid realized inflation, low inflation expectations and continued low asset prices.

In short: mild "real" recession from mid-2007 to mid-2008. Tight monetary policy (relative to where it needed to be) drove the economy off a cliff in June-August 2008. Large recession followed.

But again, this is a story that I piece together using evidence from the Great Depression and the 1987 stock market crash. The basic causality is "tight money -> financial crash -> recession." It's not the financial crash that caused the recession, it's tight money.

What I need to do now is piece together a causal story that is plausible to people other than monetary economists.

You'll get a Nobel Prize in 30-40 years if you can prove it.

 

[Monsterzuma]

@ integral; I'm guessing you see eye to eye with Scott Sumner on a lot of things?


Link to video.

lengthier presentation:
http://www.youtube.com/watch?v=ktlRWF-NwwE&feature=related
blog:
http://www.themoneyillusion.com/

 

[Integral]

I've spoken with Scott on his blog a number of times, though I have yet to meet him and discuss things in person. (He even mentioned me in a post yesterday!) He's been an important influence in shaping my views. I still think that he hasn't yet really worked out a good causal story for the critical May-September 2008 period. Everything else clicks.

I break with him in that he doesn't think interest rates matter all that much, whereas I take the neo-Wicksellian view that interest rates do matter, albeit relative to the "natural rate of interest" and not in their levels per say. I see interest rates as a useful and meaningful shortcut; he doesn't.

 

[JerichoHill]

I ain't Tomas Dolby, science doesn't blind me.
Think you're smart? Form a line behind me!
You won't find me, truth to tell,
to be a man who suffers fools very well.
Quite the opposite, in fact;
ain't got time to interact...



Nonsense. Over half of our budget is spent on entitlements, and entitlements are the Democrats' sacred cows. The Republicans' sacred cow is the military, which only accounts for less than 20% of the budget.

No. Both views (Cutlass) and yours are incorrect. The continuation of unnecessary tax cuts for a minor recession which relatively benefited those who didn't need it (the rich) combined with a renewed push on homeownership, continuing a faulty policy from the previous admin (Clinton) pushed households into riskier portfolios, inflated housing values, and then, coupling that with deregulation of glass steagall and piss poor oversight into lending regulations (credit, mortgage) equated to what happened in late 2008. Further, you are forgetting that Dems and Reps pushed through the Medicare Pres Drug Plan, signed by a Rep, and that policy was untenable.

No one escapes with less mud.